What Do the Earnings of Discount Stores Reveal?

Sarfaraz is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The discount retailer Dollar Tree (NASDAQ: DLTR) looks more attractive after it reported solid results as the company has effectively maneuvered itself through challenging business conditions.  On the other hand, earlier this month, its rival Dollar General (NYSE: DG) released its first quarter earnings that met the market’s expectations. But the company lowered its guidance causing a considerable drop in its shares. Unfavorable weather, intense competition, increasing sales of consumables and lower margin goods is having a negative effect on its profitability. 

Dollar General's revenues increased by 8.5% to $4.23 billion , slightly below analysts’ expectations of $4.24 billion. Same store sales rose by 2.6% on the back of an increase in the number of average transactions and higher customer traffic. Net income rose by 3.1% to $220 million or $0.67 per share which translates into adjusted earnings of $0.71 per share, in-line with the analysts estimate.

The revenue growth was led by consumables, which contributed more than 70% to its revenues. Here, Dollar General witnessed a double digit growth in sales but lacklustre performance of other segments shows that the low income shoppers are struggling; there is financial pressure on consumers who have increased their purchases of consumables while sales of non-essential items continues to suffer. An increase in “shrink” or theft, coupled with the increase in items priced at more than $5 has also hit its bottom-line.

<table> <thead> <tr><th> <p><strong><span>Dollar General: Quarterly Sale by category</span></strong><strong><span></span></strong></p> </th></tr> </thead> <tbody> <tr> <td> <p><strong>Category</strong><strong></strong></p> </td> <td> <p><strong>2013</strong><strong></strong></p> </td> <td> <p><strong>2012</strong><strong></strong></p> </td> <td> <p><strong>% Change</strong><strong></strong></p> </td> </tr> <tr> <td> <p>Consumables</p> </td> <td> <p>$2,877</p> </td> <td> <p>$3,195</p> </td> <td> <p>11.00%</p> </td> </tr> <tr> <td> <p>Seasonal</p> </td> <td> <p>$525</p> </td> <td> <p>$529</p> </td> <td> <p>0.90%</p> </td> </tr> <tr> <td> <p>Home Products</p> </td> <td> <p>$259</p> </td> <td> <p>$266</p> </td> <td> <p>2.60%</p> </td> </tr> <tr> <td> <p>Apparel</p> </td> <td> <p>$240</p> </td> <td> <p>$244</p> </td> <td> <p>1.40%</p> </td> </tr> </tbody> </table>

Dollar Tree Takes the Lead

Dollar General’s rival Dollar Tree has reported impressive results for its most recent quarter. The company saw its revenues growing by 8.3% to $1.87 billion while Its net income increased 15% to $133.5 million or $0.59 per share. Comparable sale increased by 2.1% in the quarter. The growth in revenue is partly attributed to stronger performance of its discretionary unit as compared to consumables.

While Dollar General and Dollar Tree have reported similar top line growth rates, their competitor Family Dollar (NYSE: FDO) reported an 18% increase in sales.

<table> <thead> <tr><th> <p><strong>Qtr Revenue (In Millions)</strong></p> </th><th> <p><strong>2012</strong></p> </th><th> <p><strong>2013</strong></p> </th><th> <p><strong> Change</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p>Dollar General</p> </td> <td> <p>$3,901.20</p> </td> <td> <p>$4,233.73</p> </td> <td> <p>+8.5%</p> </td> </tr> <tr> <td> <p>Dollar Tree</p> </td> <td> <p>$1,723.60</p> </td> <td> <p>$1,865.80</p> </td> <td> <p>+8.3%</p> </td> </tr> <tr> <td> <p>Family Dollar</p> </td> <td> <p>$2,458.63</p> </td> <td> <p>$2,893.99</p> </td> <td> <p>+17.7%</p> </td> </tr> <tr> <td> <p><strong>Qtr Net Income (In Millions)</strong></p> </td> <td> </td> <td> </td> <td> </td> </tr> <tr> <td> <p>Dollar General</p> </td> <td> <p>$214.42</p> </td> <td> <p>$220.08</p> </td> <td> <p>+2.6%</p> </td> </tr> <tr> <td> <p>Dollar Tree</p> </td> <td> <p>$116.10</p> </td> <td> <p>$133.50</p> </td> <td> <p>+15.0%</p> </td> </tr> <tr> <td> <p>Family Dollar</p> </td> <td> <p>$136.42</p> </td> <td> <p>$140.15</p> </td> <td> <p>+2.7%</p> </td> </tr> <tr> <td> <p><strong>Gross Profit Margin</strong></p> </td> <td> </td> <td> </td> <td> </td> </tr> <tr> <td> <p>Dollar General</p> </td> <td> <p>31.48%</p> </td> <td> <p>30.59%</p> </td> <td> <p>-90 basis points</p> </td> </tr> <tr> <td> <p>Dollar Tree</p> </td> <td> <p>35.00%</p> </td> <td> <p>35.20%</p> </td> <td> <p>+20 basis points</p> </td> </tr> <tr> <td> <p>Family Dollar</p> </td> <td> <p>34.87%</p> </td> <td> <p>33.42%</p> </td> <td> <p>-150 basis points</p> </td> </tr> </tbody> </table>

The comparable quarterly performance of the three is presented in the table above. Dollar Tree has reported the largest increase in net income from the same quarter last year and it is the only one, out of the three, whose gross profit margin has risen. For Dollar General and Family Dollar, the drop in profit margin is due to increase in sales of lower margin consumables. Moreover, the two are also adding other lower margin products, such as Tobacco, to their shelves which is driving down the profitability. I expect this trend to continue in the future as well, partly due to increasing competition from Wal-Mart, which is discussed later.

Saturation Point

The dollar stores are adding hundreds of new stores across the nation while their larger rivals, particularly Wal-Mart, are also taking similar measures through smaller outlets. In this competitive environment, this strategy is the key towards improving, or even maintaining the market share.

Dollar General opened 165 new stores in quarter and that took the total store count to 10662. Meanwhile, Family Dollar, to keep pace with its competitor, opened 126 new stores taking its total count to 7675. Similarly Dollar Tree, which operates larger stores in terms of covered area as compared to Dollar General and Family Dollar, opened 94 new stores and  its total store count reached 4763. Naturally, the aggressive expansion plans cannot go on forever and the market will eventually hit the saturation point.

<img alt="" src="http://g.fool.com/editorial/images/49625/002_large.jpg" />

Long term vs. Short term

For dollar stores, some improvements are expected in the coming quarters due to an end to the cold weather. Secondly, the better job numbers should also offset, at least to some extent, the negative impact coming from payroll taxes.

The management of Dollar General in particular has pointed out that it is taking the necessary steps to bring down the theft levels.

However, I believe that the bigger issue for this industry is to figure out how it is going to continue its growth as the saturation point, discussed earlier, approaches.

Then, there is the growing competition from Wal-Mart which is looking to eliminate the Dollar stores’ competitive advantage: their location in residential areas. The retail behemoth is opening new neighborhood stores and a recent survey by Bloomberg has revealed that Wal-Mart was offering lower prices in household goods, grocery, auto supplies, pharmacy and beauty aids. Thus because of Walmart, the dollar stores are forced to keep a lid on their prices. In the long term, as the competition intensifies, I believe that the dollar stores will be forced to reduce their prices and their margins will take the hit. 

In other words, while there are reasons to be optimistic about the coming quarters, over the longer term, the situation isn’t looking rosy.

For Dollar General, the soft sales of non-consumables could create more problems in the future. The company’s shares have also struggled and have fallen by 2% in the last four weeks due to its weak guidance Family Dollar believes that consumer’s discretionary spending will remain challenging throughout the year.

As a result, the stocks of Dollar General, Family Dollar and Dollar Tree have remained under pressure. However, there is an opportunity here. Add Dollar Tree’s superior performance and little complains -- particularly about the cold weather -- to the equation and I believe that this makes its shares more attractive than its rivals, particularly for the short term. Several analysts, including Goldman Sachs and MKM Partners, are bullish on Dollar Tree and have recommended a “buy” rating. 


Sarfaraz Khan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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